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Supreme Court Denies Lien Stripping Case, For Now

August 31, 2015

One of the main benefits of bankruptcy is the ability of the debtor to restructure his finances, and, in some cases, modify debts by reducing principle or changing terms, like the interest rate or length of the contract. The opportunity to modify an underwater home mortgage is obviously an enormous benefit for someone struggling to pay bills and keep his family home. Unfortunately, Congress made it clear that Chapter 13 debtors may not modify a primary home mortgage (see 11 U.S.C. § 1322(b)(2)), and the U.S. Supreme Court decided that modifying an upside-down home mortgage is not available for Chapter 7 debtors in the case of Dewsnup v. Timm, 502 U.S. 410 (1992).

The Supreme Court of the United States recently reversed two Eleventh Circuit decisions that allowed lien stripping entirely unsecured junior liens in Chapter 7 cases. The Court relied on Dewsnup v. Timm, but several of the justices did not seem especially keen on the outcome.

The two Eleventh Circuit cases both concerned Chapter 7 debtors who attempted to “strip off” and discharge unsecured second mortgages using Section 502(d) of the Bankruptcy Code. In each case, the Bankruptcy Court, the District Court and the Eleventh Circuit allowed the debtor to “strip off” the junior mortgage and void the lien.

In a unanimous decision by the Supreme Court, Justice Thomas reversed the Eleventh Circuit. First, the Court agreed with the debtors. Thomas examined the plain language of the Bankruptcy Code and found that under Section 506(d), a lien that secures a claim against the debtor that is not an “allowed secured claim” is void:

The Code suggests that the Bank’s claims are not secured. Section 506(a)(1) provides that “[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,” and “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” In other words, if the value of a creditor’s interest in the property is zero—as is the case here—his claim cannot be a “secured claim” within the meaning of §506(a). And given that these identical words are later used in the same section of the same Act—§506(d)—one would think this “presents a classic case for application of the normal rule of statutory construction that identical words used indifferent parts of the same act are intended to have the same meaning.” (citation omitted). Under that straightforward reading of the statute, the debtors would be able to void the Bank’s claims.

Bank of America v. Caulkett, No. 13-1421, p. 3 (6/1/15). It seemed like the debtors would have a clear victory, however the Court quickly stomped on the debtors’ throats with a big black boot:

Unfortunately for the debtors, this Court has already adopted a construction of the term “secured claim” in §506(d) that forecloses this textual analysis.

Id. The Court explained that its prior holding in Dewsnup dictated a different result:

Rather than apply the statutory definition of “secured claim” in §506(a), the Court reasoned that the term “secured” in §506(d) contained an ambiguity because the self-interested parties before it disagreed over the term’s meaning. (citation omitted). Relying on policy considerations and its understanding of pre-Code practice, the Court concluded that if a claim “has been ‘allowed’ pursuant to §502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of §506(d).” (citation omitted). It therefore held that the debtor could not strip down the creditors’ lien to the value of the property under §506(d) “because [the creditors’] claim [wa]s secured by a lien and ha[d] been fully allowed pursuant to §502.” (citation omitted). In other words, Dewsnup defined the term “secured claim” in §506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim. Under this definition, §506(d)’s function is reduced to “voiding a lien whenever a claim secured by the lien itself has not been allowed.”

Opinion, p. 4. Consequently, relying on Dewsnup the Court found that the unsecured second mortgages could not be avoided because the debts are “allowed secured claims” under Section 502.

However, Justice Thomas included the following interesting footnote to the case:

From its inception, Dewsnup v. Timm, 502 U. S. 410 (1992), has been the target of criticism. (citations omitted). Despite this criticism, the debtors have repeatedly insisted that they are not asking us to overrule Dewsnup.

Justices Kennedy, Breyer and Sotomayor expressly joined in all of the opinion except for the footnote. This may be an open invitation by the Supreme Court to re-examine Dewsnup and have the case overturned.

If you are considering filing for bankruptcy please call the experienced attorneys at Fears Nachawati Law Firm to set up a free consultation. Call 1.866.705.7584 or send an email to fears@fnlawfirm.com.

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